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Flexible Retirement and Optimal Taxation

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  • Abdoulaye Ndiaye

    (Northwestern University)

Abstract

This paper studies optimal income taxes and retirement benefits in a life-cycle model with an intensive margin of labor supply and an endogenous retirement age. The government insures and redistributes resources across individuals who privately observe persistent shocks to their productivity. In this environment, the optimal labor tax is hump-shaped in age, unlike in existing models with no endogenous retirement choice, in which the optimal tax is everywhere increasing. Because of the retirement margin, the total Frisch elasticity of labor supply increases with age. This elasticity effect flattens the labor tax for old workers relative to the model without an extensive margin. In addition, as high-productivity workers retire later than low-productivity workers, the distribution of productivity in the labor force features, over time, a higher mean and lower variance than in the general population. This novel composition effect pushes for a labor tax that declines for old workers. Optimal policy balances these effects with the insurance benefits of taxation, yielding the hump-shape in tax rates. In numerical simulations, the optimum achieves sizable welfare gains that approximately optimal age-dependent taxes fail to capture under the current US Social Security system. Yet, an optimal combination of age-dependent linear taxes with increasing-in-age delayed retirement credits generates welfare gains that are close to those from the optimum.

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  • Abdoulaye Ndiaye, 2018. "Flexible Retirement and Optimal Taxation," 2018 Meeting Papers 535, Society for Economic Dynamics.
  • Handle: RePEc:red:sed018:535
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    Cited by:

    1. Moser, Christian & Olea de Souza e Silva, Pedro, 2019. "Optimal Paternalistic Savings Policies," MPRA Paper 95383, University Library of Munich, Germany.
    2. John Bailey Jones & Yue Li, 2020. "Social Security Reform with Heterogeneous Mortality," Working Paper 20-09, Federal Reserve Bank of Richmond.
    3. Thomas F. Cooley & Espen Henriksen & Charlie Nusbaum, 2019. "Demographic Obstacles to European Growth," NBER Working Papers 26503, National Bureau of Economic Research, Inc.
    4. Cirelli, Fernando & Espino, Emilio & Sánchez, Juan M., 2021. "Designing unemployment insurance for developing countries," Journal of Development Economics, Elsevier, vol. 148(C).
    5. Heathcote, Jonathan & Storesletten, Kjetil & Violante, Giovanni L., 2020. "Optimal progressivity with age-dependent taxation," Journal of Public Economics, Elsevier, vol. 189(C).
    6. Borys Grochulski & Yuzhe Zhang, 2019. "Wealth Effects with Endogenous Retirement," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 173-200.
    7. Odran Bonnet & Guillaume Chapelle & Alain Trannoy & Etienne Wasmer, 2019. "Secular Trends in Wealth and Heterogeneous Capital: Land is Back... and Should Be Taxed," Sciences Po Economics Discussion Papers 2019-14, Sciences Po Departement of Economics.
    8. Takao Kataoka & Yoshihiro Takamatsu, 2020. "Optimal age‐dependent income taxation in a dynamic extensive model: The case for negative participation tax on young people," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 22(5), pages 1338-1367, September.

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    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H55 - Public Economics - - National Government Expenditures and Related Policies - - - Social Security and Public Pensions
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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